Finding “blue oceans,” a perfect niche market with no competitors is a challenge. That’s why producers focus on their existing customers trying to retain them and keep their business on top. In this regard, the only strategy that works is to accurately plan and manage all business processes, providing 24/7 control of both manufacture and delivery processes. Inventory management and warehousing is the main performance indicator not only for retailers but also for producers.
The basic aim of inventory management is to make the right product available on the warehouse shelf in the right time. The tiniest mistake in warehousing may lead to customer loyalty decrease, missed profits and even loss of market power.
At the same time, it is important to find the right balance between the lack of inventory and over-stock. Excess inventory often freezes large volumes of operating assets. This may increase warehouse, personnel and equipment management costs, as well as cause excess inventory damage and obsoletion.
Businesses that have managed to find this balance between “whether or not to”, say that rational inventory management is a key to success. At the same time, they recommend being careful with the extreme approaches to warehousing.
Extreme approach number 1: The more inventory you have, the better.
Customers buy products when they need them, not when they have the possibility to buy. Clearly, having extra stock keeps you in the red. 20th century’s trends of doing business are gone. Companies no longer have to store excess stock to save on bulk reductions and goods delivery.
Business never stops. A new competitor with a wider product range and better goods choice, can literally appear from nowhere and conquer your market. Having an excess inventory will not be an effective weapon in this battle.
Extreme approach number 2: Keeping inventory does you harm
When inventory levels go lower, a retailer is happy. Operating assets are not being tied up, you are more flexible and reactive to changing market conditions. However, keeping irrationally low inventory levels can cause lost sales and considerable penalties.
How to find a rational balance?
One would think, automated inventory management software of MRP, МRPII, ERP and APM types are created to help you find this balance. The specification-based forecast was the solution initially created to solve an eternal problem of all suppliers. A simplified forecast technique was used for dozens of years. However, these techniques, even the most sophisticated ones, can not guarantee 100% of forecast accuracy. This does not mean the formulae are not correct, this only means that the forecast conditions have changed greatly.
Earlier, safety stock was measured with the help of forecast error. The higher the level of forecast accuracy, the less safety stock we need to store. Not exactly. Let’s have a look. We have short-term KPIs. And imagine, these rules have been developed for another planning perspective, and this perspective is not relevant anymore. A forecast is a tool, which is constant, it does not vary with methods, KPIs or planning options.
The more long-term the forecast is, the less accurate it has. The delivery forecast for the next week is by default more accurate than a forecast for the next four weeks.
The forecast is never 100% accurate.
Forecast techniques are changing rapidly, however, they can not catch up with the pace of forecast environment development, its complication and segmentation. This difference not too critical in a short-term perspective. Here is a graph to illustrate:
The total sales volume has not changed much, while the quantity of SKUs in a product assortment dramatically increased, and the percentage of each SKU decreased (became more segmented). The forecast environment has become more complicated. So, in this case, anyone please tell me, how can safety stock be measured?
You can refine your inventory planning processes either within specifications or within the whole sales and operations planning.
Inventory can not be managed in a single area of a supply chain. To make it work smoothly you need to control the whole process – from raw materials delivery and production to warehousing. All areas of a supply chain shall transparently work in a well-orchestrated manner.
Let’s have a look at the several scenarios of a more sophisticated approach to inventory management within a SKU:
Scenario 1.
We have a product under FPA. Its production cycle equals 35 days. This term includes a 25-day Pre-Pay and Add (PPA) component delivery, which is the longest area of a supply chain, and a 10-days actual production time under FPA. The latter is available if all components have been provided.
The finished product value is USD 1000. On average, we need 85 units. So, the investment for this SKU under FPA is USD 85 000.
Scenario 2.
Let’s take the same finished product under FPA. Let’s imagine how managing a PPA component can influence the inventory within the whole chain.
- The cost per PPA-unit is USD 100. We have 112 units in stock. So, the cost of investment under PPA is USD 11 200.
- We do not have to wait until the units under PPA are being delivered and we can plan our production according to a shorter supply chain cycle. So we can produce a finished FPA-product in 14 days instead of 35. This means we need less inventory in our warehouses. We have calculated that FPA-safety-buffer equals to USD 41 000.
- The total investment is USD 11 200 + USD 41 000 = USD 52 200.
The message is clear:
- If the inventory is managed properly, the production cycle is reduced from 35 to 14 days.
- The cost of investment is decreased from USD 85 000 to USD 52 200.
Business shall always take all running it can do to at least keep in the same place. Today this is not enough. To be successful and to stay on top business has to innovate, to become agile and flexible, to implement revolutionary approaches to its doing business. Innovative inventory management is one of the fundamental elements of a modern supply chain participants.
Remember, your stock is your leverage.
The next-generation methodology DDMRP (Deman Driven Institute) says – focus on inventory use, instead of its quantity.
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